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Investment Overview for Dr Pepper Snapple (NYSE:DPS)

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Below are key drivers of Dr Pepper Snapple that present opportunities for upside or downside to the current Trefis price estimate:

North America CSD

North America CSD EBITDA Margin : EBITDA margins for the North American CSD segment of the company have shown flat to negative growth in the last three years primarily because of high commodity prices. Cost of sales now constitute more than 42% of the revenues. EBITDA margins for 2013 were 22.4%, down 0.9% from the previous year. Should the cost of sales rise further and we see the long term margins falling to 21%, we could see a 12% downside to the Trefis price estimate. At the same time, if the cost of sales soften and the company is able to touch margins of 25%, we could see a 7% upside to the Trefis price estimate.

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Dr Pepper Snapple is the third largest Liquid Refreshment Beverage(LRB) company in the U.S. with further presence in Canada, Mexico and Caribbean. Dr Pepper Snapple is a market leader in the flavored Carbonated Soda Drink (CSD) segment with its flagship drink Dr. Pepper. Besides CSD, the company is also present in juices, ready-to-drink (RTD) teas and mineral water, among others. Some of the company's most valuable brands are Dr Pepper, 7UP, Canada Dry, Sunkist, Crush and Snapple.

Dr Pepper Snapple was formed in 2008 as a spin-off from Britain's Cadbury Schweppes. Cadbury Schweppes separated the Americas beverages from its global confectionery business and the entity thus formed was labeled Dr Pepper Snapple.

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Dr Pepper Snapple derives its value primarily from its North American CSD operations.

Low/no calorie soft drinks are presently the worst performing category of the U.S. beverage market. Dr. Pepper Snapple uses the artificial sweetener "aspartame", which is considered unsafe, and also known to leave a bitter aftertaste. Due to this, sales of the company's TEN product lineup remained flat during 2013.
Unless a safer alternative is used, Dr. Pepper Snapple's diet soda volumes might continue to fall.

Dr Pepper Snapple's market share in the North American might remain stagnant

CSDs in the U.S. is a mature market, where most of the revenue is constituted by three main players: Coca-Cola, PepsiCo and Dr. Pepper. This market has consolidated over time and growth rates are expected to remain flat to negative in the next few years.
Dr. Pepper has managed to nab only 0.4% market share from its competitors in four years. Going forward, we expect hardly any movement in the company's North America CSD market share of around 17%.
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Dr Pepper Snapple has a very limited exposure to emerging markets

Dr Pepper Snapple derives 93% of its revenues from the U.S. and Canada out of which the U.S. constitutes 89%. Only 7% of the revenues are derived from the emerging economies of Mexico and Caribbean. In the U.S., the CSD market size is declining due to consumers predilection for healthier products. Unless the company invests significantly in Mexico and Caribbean, we believe that there is very limited upside to the company's valuation as developed markets are showing signs of saturation.

Possible decline in Mexico volumes due to high obesity and diabetes rates

Mexico has the world's worst obesity rate of 32.8%. In addition, the country also has a high diabetes rate of 9%, as compared to 7.7% for the U.S.
The President of Mexico has called for a "change in culture", urging people to live a healthier lifestyle and consume less CSDs. This might hamper Dr. Pepper's volumes in the coming future.
In addition, the Mexican government has imposed an added tax of one peso (~7.4 cents) on a liter of fizzy drinks, in a bid to fight health problems. Beverage companies will pass this tax on to consumers in order to meet margins. Price hike might deter demand for CSDs in Mexico.

Dr Pepper Snapple's bottling agreements with PepsiCo and Coca Cola Co give it a greater foothold in North American markets

Dr Pepper Snapple struck two bottling agreements in 2010, one with Pepsi and the other one with Coca Cola. These contracts are to be for a period of twenty years, after which they are renewable. Under the agreements, Dr Pepper Snapple will provide beverage concentrates of certain brands to Pepsi and Coca Cola who will then bottle, market and distribute it in the U.S. and Canada. The agreements give the company access to areas which have typically had low per capita consumption of Dr Pepper Snapple brands.

Dr Pepper Snapple received a one time non-refundable fees of $900 million from PepsiCo and $715 million from Coca Cola, which have been recorded as deferred revenues. The agreements provide the company with healthy cash flow as well as add stability to the revenues.

Trefis Forecast Rationale for North America CSD Market Share

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North American CSD Market Share is Dr Pepper Snapple's share (by volume) in the Carbonated Soft Drinks (CSDs) market in the North American regions of the U.S. and Canada.

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Dr Pepper Snapple had been able to increase its market share very slightly through 2009-2012 as Coca-Cola and PepsiCo increased their focus overseas. The company's market share stood at 16.9% in the North American CSD market in 2013. Going forward, as North American CSDs is a mature market, we expect the company's share to remain around 17%.

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Trefis considered the following factors for its forecast

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Renewed focus by PepsiCo on its soft drink portfolio

PepsiCo stepped up its advertising spend by $200 million in 2013 with an increased focus on the soft drinks. PepsiCo also sponsored the Superbowl along with tie-ups with 50 Cent and several movies. This can potentially affect Dr Pepper Snapple's market share negatively.

New entrants such as Kraft can potentially eat up Dr Pepper Snapple's CSD market share

New companies which are entering the CSD market are smart enough to launch only 'Diet' and 'Natural' beverages. The association of the new entrants with healthier products can potentially hurt Dr Pepper Snapple in the long run as the established soft drink companies are perceived for promoting obesity.

Dr Pepper has been scaling up production and distribution capacity in North America

Dr Pepper Snapple's bottling agreements with PepsiCo and Coca-Cola give it greater foothold in the North American markets. The agreements were formed in 2010 for a period of 20 years. The agreements give the company access to areas which have typically had low per-capita consumption of Dr Pepper Snapple brands.

Dr Pepper Snapple is continuously making distributional gains. In 2013, the company gained additional shelf space for CSDs in convenience stores, thereby increasing all-commodity volume by 0.3 percentage points in measured channels. According to the company, its CSD volume in the drugstore channels rose by 8.4 percent, outpacing the category by more than 2 percentage points.

Increased marketing spend

Dr Pepper Snapple spent $486 million on marketing in 2013 with focus on the low calorie TEN lineup, with plans to spend 7.5% of net sales on marketing in 2014 and around $30 million on the TEN lineup.

Dr Pepper Snapple has stepped up marketing aimed specifically at Hispanics who show a preference for flavored beverages. The company has partnered with Carlos Santana and sponsored the Latin Grammy Awards.

Strong brand loyalty among Dr Pepper and Diet Dr Pepper's brands

The company boasts of its flagship drink Dr Pepper as having a unique flavor. Within the CSD segments, colas have multiple brands with very little taste variation. However, Dr Pepper enjoys strong customer loyalty since no rival drink has a similar taste. The company enjoys a dominance in the 'flavors' category.

Dr Pepper and Diet Dr Pepper are two of the very few beverages within CSD that have consistently been able to increase the volume despite an overall decreasing market size.

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Use of aspartame in diet sodas could decrease Dr. Pepper's market share

Diet soft drinks are the worst performing segment of the U.S. beverage market. Consumers spent 7.2% less year-over-year on diet cola drinks and 7.8% less on diet citrus drinks through November 2013.

Consumption of diet drinks such as Dr. Pepper's TEN lineup has been targeted due to usage of the artificial sweetener "aspartame". Recent studies have argued that this artificial sweetener can cause serious health problems along with sugar cravings, dehydration and even weight gain. In addition, aspartame is known to leave a bitter aftertaste.

Coca-Cola plans to introduce Coke Life in the U.S., a low calorie drinks containing stevia, an artificial sweetener which is considered safe.

On the other hand, PepsiCo has also filed a patent application to commercialize the usage of Reb D, a stevia derivative, presumed to have tackled the problem of bitter aftertastes.

As Dr. Pepper's diet offerings contain aspartame, it faces a possibility of losing further market share to Coca-Cola and PepsiCo, which already hold about 70% of the market.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.

We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

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